S&P 500 surges above 4700 despite hawkish Fed signalling three rate hikes in 2022

US equities rallied in wake of the latest Fed policy announcement and post-meeting press conference with Fed Chair Jerome Powell. The S&P 500 gained more than 1.6% to close back above 4700, only a whisker away from record closing levels. Meanwhile, the Nasdaq 100 index was up more than 2.0% and pushed easily back above the 16K level to near 16.3K, while the Dow gained over 1.0% and nearly recovered back to the 36K level. The VIX dropped nearly three points to just above 19.0.

On balance, Wednesday’s Fed meeting was a hawkish affair. While the bank left rates unchanged at 0.0-0.25%, it doubled the pace of QE taper in January to $30B per month as expected and its dot-plot showed that the median expectation amongst Fed policymakers is for three rate hikes in 2022. This was at the hawkish end of expectations (some had expected the dot-plot to indicate two hikes next year). In the press conference, Powell talked about how the economy was very strong and how rate hikes would be appropriate to maintain price stability, which would prolong the expansion and ensure a more durable return to pre-pandemic labour market conditions.

Despite the Fed’s hawkishness, stocks rallied, with the driver of this rally unclear. Some cited a sell the rumour, buy the fact reaction. That is to say, traders were positioning themselves cautiously in the run-up to the Fed meeting and, once the risk event was out of the way (even though it was a tad more hawkish than anticipated), markets got the green light to rally. Some said that, with the final major US risk event now out of the way for 2021, the typical December “Santa rally” can properly kick into gear.

Another factor that could have been bullish for markets was the Fed maintaining its stance that, despite the risks posed by Omicron, the Fed remains very bullish on the US economy for 2021 (instilling confidence in forecasts for earnings growth). Meanwhile, Powell noted how if growth did slow, the pace of rate hikes could also be slowed as the Fed responds to changing economic conditions. That was a comforting message to investors, some of whom have become fearful that the Fed would not be there to support a weakening economy if inflation remained elevated.